The Economy

THE PERUVIAN ECONOMY achieved a higher rate of economic growth than
the average for Latin America from 1950 to 1965, but since then has
turned from one of the more dynamic to one of the most deeply troubled
economies in the region. Even in the period of rapid growth, Peru was
characterized by exceptionally high degrees of poverty and inequality,
and since the late 1980s poverty has become much worse. Major changes in
economic strategy introduced in 1990 and 1991 offer new hope for future
growth but have not been oriented toward reduction of poverty and
inequality.

In the first post-World War II decades, Peru achieved an
above-average rate of growth with low levels of inflation and with
rising exports of its diversified primary products. Output per capita
grew 2.9 percent a year in the decade of the 1950s and then 3.2 percent
annually in the first half of the 1960s, compared with the regional
growth rate of 2.0 percent for these fifteen years. As of 1960, income
per capita was 17 percent above the median for Latin American countries.
However, since the mid1960s the economy has run into increasing
difficulties. Output per capita failed to grow at all from 1965 to 1988,
then fell below its 1965 level in 1989 and 1990. The previously moderate
rate of inflation accelerated, balance of payments deficits became a
chronic problem, and the country accumulated a deep external debt. As
poverty worsened, political violence in the countryside and cities grew
increasingly intense. The economy and the society as a whole seemed to
lose coherence and any sense of direction.

The reasons for this deterioration from 1965 to 1991 are complex and
very much open to debate. Many aspects of the debate center on two
opposing conceptions of what national economic strategy and goals should
be. One conviction is that the best course is to keep the economic
system open to foreign trade and investment, to avoid extensive
government intervention in the economy, and to rely mainly on private
enterprise for basic decisions on production and investment. The
contrary conception favors restricting foreign trade and investment
while promoting an active government role in the economy to accelerate
industrialization, to reduce inequality, and to control the actions of
private investors. The conflict between these economic models is
familiar in the experience of all Latin American countries. The failure
to reconcile them in Peru has been an important factor in the
deteriorating economic performance since the mid-1960s.

At least five interacting problems have been important in the
explanation of why the economy has deteriorated so badly since the
mid-1960s. First, natural resource limits began to handicap further
expansion of primary product exports, requiring difficult changes in the
structures of production and trade. Second, partly in response to these
constraints, and partly as a matter of a growing conviction that the
country needed to industrialize more rapidly, successive governments
began to promote industrialization through protection against imports,
reversing the country's traditional policy of relatively open trade.
Third, dissatisfaction with widespread inequality and poverty encouraged
attempts at radical social change, but the two governments that tried to
lead the way--those of General Juan Velasco Alvarado (1968-75) and Alan
García Pérez (1985-90)--failed to find any effective answers or to
maintain viable macroeconomic policies. Fourth, the temporary move back
toward a more open economy under the second government of Fernando Belaúnde
Terry (1980-85) resulted in a surge of imports and an external
crisis--mainly because of currency overvaluation and an excessively
rapid rise of government spending--that again discredited this approach.
And finally, rural violence took on a profoundly destructive character
with the growth of the Shining Path (Sendero Luminoso-- SL) and the
cocaine industry. On top of those two sources of violence, weakening
governmental capability to maintain order and worsening conditions of
employment led to growing security problems in cities.

Deteriorating conditions since the mid-1960s need to be considered
against the background of a deeply divided society and a considerable
lag, compared with many other Latin American countries, in developing
either a competitive industrial sector or a modern structure of public
administration able to implement public policies effectively. These
handicaps can be overstated. After all, the Peruvian economy functioned
well up to the mid1960s , and both private business and government
officials have gained experience since then. As of the beginning of the
1990s, however, the country's prolonged decline had seriously undermined
public confidence in the possibilities for recuperation and renewed
growth.

The most evident symptoms of the crisis at the beginning of the 1990s
were falling national output and income, high levels of unemployment and
underemployment, worsening poverty and violence, accelerating inflation,
and deep external debt. Under the Belaúnde administration, the external
debt grew too high for Peru to meet scheduled service payments, although
the government maintained the position that payments would be resumed
when possible. Under the next government, García made a point of
declaring that payments would be unilaterally limited to 10 percent of
export earnings. His more aggressive position led to a near-total cutoff
of external credit, which remained in effect throughout his term.

The government of Alberto K. Fujimori (1990- ) adopted a drastic
stabilization program to break out of this complex of problems by first
attacking the forces driving inflation. The initial shock of the new
measures, which more than doubled the consumer price level in a single
day, nearly paralyzed markets and production. After a steep fall in
output, the economy began to stabilize with a lower rate of inflation
but without any strong signs of recovery. Although the Fujimori program
included many lines of intended action beyond the initial shock, it
remained incomplete in many respects. It raised a host of questions
about what other policies would reactivate the economy while preventing
any further burst of inflation, and how long it would take to restore
something like Peru's earlier capacity for growth.